How the Current Economy Works – In English

By: Brian C. Beasley, CPWA®

Over the past 16 years, I’ve worked with some pretty wonderful clients. Their input has greatly shaped not only my business decisions, but some personal ones too. One of the best pieces of advice I’ve received has been, “SPEAK ENGLISH!” Without a doubt, our industry and the media have done a pretty good job complicating the economy and markets. Today, many people throw in the towel and say, “I just don’t understand that stuff.” That might work if you have a truly competent advisor that you can trust. But if you don’t understand the world you live in, you’re bound to make some big mistakes. Hopefully this will help you make some good decisions moving forward.

The Economy
An economy is people buying goods and services from one another. That’s it. Don’t forget it. It’s really that simple. Key Concept #1: More people buying more “stuff” results in a bigger economy. Fewer people buying fewer things results in a smaller economy. The CIA World Factbook estimates that the size of the U.S. economy was about $14.14 Trillion in 2009. So who spends all that money? Let’s keep it pretty simple. The largest piece of the economy has traditionally been the private sector. The other portion is government spending. Here is the government’s portion of our Gross Domestic Product (GDP) over time.

688 Lee Street – Des Plaines, IL 60016 – TEL: 866-ATHENA1- www.ATHENA1.com Securities and Advisory Services offered through LPL Financial, a Registered Investment Advisor – Member FINRA/SEC

The remainder of our economy is the private sector. This spending is from actual consumers buying everything from houses to cell phones to groceries. Currently, consumer spending is slightly less than 60% of the overall economy. Let’s look at these consumers a little more closely.

Consumer Spending
Most of you are aware that after World War II, our nation’s soldiers came home, got married, and had a LOT of babies. This Baby Boom lasted from 1946 through 1964, and resulted in a generation totaling nearly 80 million people. This generation’s impact on our economy is now common knowledge. There are two other major generations that followed. These were, Generation “X” (born between 1965 and 1978) and Generation “Y” (born 1979-1994). Generation X is only about 20-30 million strong. Generation Y is nearly the size of the “Boomers” at 60-70 million, depending on the source. Research done by Harry S. Dent (www.hsdent.com) has shown that consumer spending peaks in our mid40’s. This “peaking” in spending habits has been relatively constant for over 100 years. Key concept #2: Consumer spending peaks when people are in their mid-40’s. Right now, the boomers have peaked in their consumer spending. They are moving into a phase of life where they are more likely to save than to spend. The next generation is less than half as large. And Generation Y won’t hit their mid 40’s for another 10-15 years. We are likely to have a period where there are fewer people in those peak spending years of their life. As a group, Boomers are shifting from spending to saving—from borrowing to paying down debt. But there’s that other piece of the economy…

Government Spending
The government (Federal, State, and Local) makes up 44% of our $14 Trillion economy in the U.S. Where does all that money come from? The government is almost entirely dependent on revenue from taxing the private sector. Here is the rough breakdown of that spending in 1968 and 2008.

Obviously, the Government provides a lot of services and help to people. The problem they are facing now is two-fold. First, they are spending much more than they can bring in from taxes. Here’s an estimate from our recent 3rd Quarter Outlook:

This is just the Federal deficit estimate, which assumes that our economy will grow at 4.5% in each of those years. Many states and local governments also have similar budget challenges. Secondly, our government owes a ton of money in debt (rock) and unfunded promises (hard place). In a recent speech by the Chairman of the Joint Chiefs of Staff, Admiral Mike Mullen said that the single biggest threat to our national security is the national debt. Adding public debt, government sponsored entities (like Freddie Mac and Fannie Mae), and unfunded promises (Social Security and Medicare)—the total is over $100 Trillion! Key Concept #3: Our government’s spending and promising habits are completely unsustainable.

What can the Government do?
Our government can basically go down two paths. They can either reduce their spending or increase their spending. Let’s talk about these: Reduced Spending (austerity): What might happen if government spending is reduced to balance the budget? • • • The economy shrinks by the amount of the spending cut, causing some serious short-term pain Public services get cut, reduced or eliminated A political backlash toward anyone with the courage to make these cuts

Continued Deficit Spending: So what if the politicians can’t gather the political will to balance the budget for now and the future? The good news (in the short term) is that government services continue as they have for the past years. Everyone can continue to live in blissful ignorance of the fact that there will EVENTUALLY be a reckoning with all the debt & unfunded promises. More importantly, how can the government continue to fund such spending? There are basically three options. 1. Taxes: Taxes are the favored method of getting money for government services. The thought is that if the current taxes aren’t enough, just raise them! This is fine and good, but to balance the current budget, tax revenue would have to increase by about 33% (Federal, State & Local). Think about all the taxes you pay (income, sales, property, phone, gasoline, cable TV). I think taxes are likely to rise, but it probably won’t be enough to balance the budget AND pay down the enormous debt. 2. Borrowing: The government funds the deficit by borrowing money from other people. These are Treasury Bills, Notes, and Bonds. Currently the Treasury is borrowing money at a record pace.

Data Source: U.S. Government

3. “Printing Money” (aka Devaluing the dollar or “quantitative easing”): Even for the United States Government, there is a limit to what they can borrow (especially at these rates). When investors (private, institutional, and governments) have as many treasury securities as they want, how will we fund our deficit/debt then? More than likely the Federal Reserve Bank will “print” up some more dollars and loan them to the government. This already began in 2009 as the Fed bought up many Mortgage-Backed Securities in an effort to provide stability to the financial system. So what effects will this potential “money printing” have on the economy? • • • • The value of our currency could fall The cost (in dollars) of imported goods would likely rise Confidence in the U.S. dollar could erode High inflation to hyper-inflation could result, depending on the degree of the Fed’s action

Conclusions
1. The demographic trends of the United States seem to be pointing to a severe “headwind” in consumer spending. Until Generation “Y” hits their peak spending years robust consumer spending growth is unlikely. 2. Government policy will be a major key in the coming years. Regardless of elections, our elected officials will have the same tools available to them—and they won’t like their options! Hard choices will have to be made no matter what. 3. I expect a weaker economy than any of us would like. With consumer demand falling, we should expect some assets/products to experience falling prices (deflation). I would especially expect prices of “optional” goods & services to fall. When times are tough, people cut back on things they don’t need. At the same time… 4. Expect an eventual devaluing of the U.S. dollar, with the resulting inflation to follow, especially in the necessities that people can’t cut from their budget. 5. Key Concept #4: Knowing your environment is the first step to thriving in it.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
688 Lee Street – Des Plaines, IL 60016 – TEL: 866-ATHENA1- www.ATHENA1.com Securities and Advisory Services offered through LPL Financial, a Registered Investment Advisor – Member FINRA/SEC

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